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Tuesday, November 20, 2007


freddie mac -- what a cockup the financials are in!

it's becoming clear that i cut out of my shorts and went long too early.

it's also becoming clear that the problems in the banking and financial system as a result of the housing situation are incredibly serious. the two government-sponsored agencies charged with providing liquidity to the mortgage markets -- fannie mae and freddie mac -- have seen their stock destroyed in the last six weeks. they are both making new lows today in tandem on the backs of news that freddie lost $2bn in 3q; took an $8bn hit to its equity between the loss, credit writedowns and additional loss reserving; is seeking to raise capital; and will likely cut its dividend as it seeks a way to repair its bloated balance sheet.

freddie and fannie are bumping into reserve rule limits, meaning that they will have to devote income not to purchasing more mortgages or to paying dividends but to repairing their own balance sheet. the GSEs have been the buyer of last resort in the mortgage market, and with their pace of acquisition now set to slow we can expect to see higher interest rates for mortgages across the board, even tighter lending standards, and therefore even slower year-over-year home sales.

and it is all presaging the troubles yet to be admitted by wall street banks. per a commenter at calculated risk:

I listened to the conference call - Freddie's auditors require them to call the street and get quotes on their loans and securities for pricing purposes. Under this approach, Freddie took horrific credit losses in the third quarter. Freddie is close to Lehman and Goldman which is why they have been retained to raise capital. So, the question was asked if the street (persumably Lehman and Goldman) are using the same marks to value their own positions. Remember that Lehman and Goldman gave Freddie the disasterous levels but their portfolios show no such losses. The question got a nervous laugh followed by a "we are not going there" response.

jim rogers says the decline in fannie and freddie is still in its early stages, particularly fannie. mish thinks the same way i do:

"We have begun raising prices, tightened our credit standards and enhanced our risk management practices," Piszel said. "We also continue to improve our internal controls."

My Comment: Raising prices huh? We finally have explicit confirmation of what I have been saying for a long time: Mortgage rates are going to disconnect from 10-year treasuries over default concerns. We can now add capital impairment as a reason for further disconnect.

the most direct potential consequence of a slowdown in GSE purchasing, though, is the threat to countrywide financial. cfc's business model used to consist of using borrowed money to make questionable loans and sell them on to private investors; the credit crunch reduced it to using borrowed money to make prime conforming loans and selling them on to the GSEs. if that dries up materially, countrywide is done. its credit default swaps skyrocketed on the news.

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